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401(k) Mistakes That Could Cost You Millions
00:39:33
Avoid These 401k Mistakes That Cost MILLIONS Over Time!
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- [00:01]
Brian Preston
This episode is brought to you by Lifelock. During tax season, your personal info travels to a lot of places between payroll, your tax consultant and the IRS. If your W2 gets exposed, that's just the ticket for identity thieves. That's why LifeLock monitors millions of data points every second. If your identity is stolen, they'll fix it, guaranteed or your money back. Don't let identity thieves take you for a ride. Save up to 40% your first year. Visit lifelock.com podcast terms apply 401k mistakes that literally could cost you millions.
- [00:39]
Bo Hanson
I am so excited to talk about this because we know that 401ks are one of the most powerful tools in our financial tool belt and yet there are folks out there making mistakes and making decisions that could literally cost them millions. And so we want to bring them to light today and tell you how to avoid it and how to do it better.
- [00:58]
Brian Preston
Yeah, don't listen. We do so many TikTok reacts and others that people are trying to sell you bad products. How could you not love a 401k? These things are tax advantage. They got free money. These things are wealth building machines.
- [01:12]
Bo Hanson
So we're not just talking about 401ks, although that's where we predominantly see these mistakes. We're also talking about any type of employer sponsored retirement plan. So it might be a 401k, a 403b, a 457. Some of these mistakes are even made inside of those accounts. So even if you work for an employer and if you have a retirement plan available to you, make sure you listen up because we are talking to you.
- [01:36]
Brian Preston
Yeah, so let's actually jump into these five mistakes that we see. People turn something that could be one of the most powerful tools in your wealth building machine and you fall off and fall into one of these traps and the first one that we see people fall into is just not even contributing or, or participating in their 401k.
- [01:54]
Bo Hanson
It's crazy. Your employer has made this decision. They said, you know what, we're going to make available an opportunity where you can save and it's going to be a tax incentivized way for you to save and you're going to be able to build up for your own financial independence so that one day you can do what you want, when you want, how you want. And you said, Mr. Employer, Ms. Employer, thanks so much but hard pass, I'm out. You're missing a huge opportunity.
- [02:18]
Brian Preston
I'm always when I see these shock and awe stats like 4 in 10 people with access to a 401k or employer provided plan don't contribute. This comes from CNBC. I'm like, who are these people? Because this is an incredible opportunity. And then you find out that 59% of people that don't contribute to a 401k wrongly believe that they actually are signed up and are contributing. How does that even happen?
- [02:44]
Bo Hanson
It's wild that you didn't even recognize that you weren't participating in this huge wealth building tool. And so you may be said, okay, well is it really that big of a deal? Does it even matter? We said, yes, it is that big of a deal and it does matter. So let's put some actual numbers to it. What would it look like if you avoided participating in your 401k? And how much could you be missing out on? So let's look at a case study. We said, what if you make the median household income in this country, which is $80,610, and what if you said, hey, I'm going to just contribute 10% into my 401k. Now we're going to assume, wait a.
- [03:21]
Brian Preston
Minute, we know 10% is not what we tell people, 20, 25%. But just to let you guys know, this is another conservative assumption. We assume you're probably doing a Roth IRA health savings account outside of this. So we're going to go with just a modest 10%. Plus. We didn't even talk about this. I bet a lot of these plans have matching contributions. It's also going to beef this up.
- [03:42]
Bo Hanson
That's exactly right. So if you're contributing 10% of your salary, that's going to be about $672 a month. And then we said, what if you can earn 8% on average on your investments? And we said, let's say so let's stay so conservative that we're not even going to add any like pay raises, bonuses, growth and income. Just doing 10% off of that $80,000. What does that turn into? What are you losing? What are you missing out on? Well, this is what we found. If you start at age 40 and just from age 40 out to age 65, you could contribute 10% by the time you get to retirement. Even waiting until 40 to get started, you could have almost $640,000 saved up. If you're a 30 year old and you're opting not to participate, you could be missing out on one and a half million dollars by the time that you get to retirement. And if you're a 20 year old and you say, hey, this isn't for me. I'm not going to do this. Saving 10% from the time you're 20 all the way until the time you get to retirement at 65 could be a $3.5 million portfolio.
- [04:50]
Brian Preston
I would encourage everybody. Do you see the differences between 20, 30 and 40? Guys, if you're watching this, anywhere between that range 20, 40, go to moneyguy.com resources and I want you to look at your wealth multiplier and just see how valuable compounding growth can be. And that's why this is probably a great segue is saying how do we make sure we don't fall into the first trap of not participating. By the way, for those of you who are self employed, you're thinking, why does this pertain to me? I don't want you to forget we like solo 401ks too. So just because you work for yourself, there's probably still a 401k opportunity sitting out there lying in wait for you.
- [05:32]
Bo Hanson
So what do you need to do? Just get started. 401ks are even structured now to make it super easy to set it and forget it. Hey, I'm going to pick a percentage. I'm going to have that percentage go into my 401k, maybe I'm going to pick a target retirement index fund and I don't have to think about anything else. I can just let those dollars begin working for me in an automatic and systematic way. Just taking five minutes to do that could literally mean millions of dollars for your future self. So get started and start doing it today.
- [06:06]
Brian Preston
And don't forget, as you get pay raises and so forth, keep nudging yourself forward. I don't care if it's just 1% more try to make it automatic to where you're expanding your saving and investments so you create even more success for your future self.
- [06:20]
Bo Hanson
All right, Brian, let's talk about a second huge mistake. So one is not participating at all. But the second one, it might even be just a little bit more painful. This one hurts. And this is people who decide that they are going to miss out on.
- [06:33]
Brian Preston
Their employer match who would miss out on free money.
- [06:35]
Bo Hanson
It's free.
- [06:37]
Brian Preston
And by the way, if I told you I have an investment that's going to get you 50%, or how about if I'm a very generous employer, I'm going to have a plan that's going to give you 100% guaranteed rate of return. In the financial world, there's just not a lot of things you're not even allowed to whisper Those words. So to find out that there are people that are avoiding and missing out on that free employer money, it just breaks my heart.
- [06:59]
Bo Hanson
Brian, we do all kinds of open enrollment presentations for 401k plans we work with and we always say, hey, if I were to sit outside of this presentation with a bag full of money and all you got to do is swing by and grab your money, every single one of you would swing by and grab the money. And yet we know that 22% of Americans who have access to a 401k are not getting their full employer match. They're saying, hey, Mr. Employer, Ms. Employer, no thank you, I don't like free money.
- [07:27]
Brian Preston
Well, I think we can go even further than that. Let's actually put some numbers to this. I love doing the case studies where, because we've already shown why it's important to be in your 401k. But now let's stack on that supercharger that comes with wealth building and specifically with employer provided plans that free money from your employer and their generosity.
- [07:47]
Bo Hanson
So let's run back through the assumptions again. Again, let's assume that you make the median household income which is about $80,000. Let's assume that as you invest your employer match, you can make 8% rate of return on average. And let's just assume that your employer matches 3%. So it's $202 per month, no pay raises, no increases, just that for the entirety of your career. Well, if you are a 40 year old, just missing out on that 3% match from age 40 out to age 65 could cost you almost $200,000. For a 30 year old, missing the match could cost you over $460,000. And for a 20 year old, missing out on just a 3% match could literally cost you a million dollars by the time you get to retirement.
- [08:34]
Brian Preston
And by the way, this is just the match and we've already covered because a lot of people in our earlier assumption we said let's just do 10%. If you combine these two beautiful wealth building opportunities, the numbers are even bigger.
- [08:48]
Bo Hanson
You can see that if you add the 10% savings plus the 3% match for a 40 year old missing out on that, they're walking away from $830,000. The 30 year old who decides to walk away from saving 10% and also doing a 3% match, missing out on $2 million of retirement dollars and that 20 year old who says, you know what, I'm not going to put 10% in my 401k, I'm not going to get my free 3% employer match. That single decision could be the difference of $4.6 million by the time you get to retire.
- [09:21]
Brian Preston
When I get super excited about bringing these two concepts together, you putting 10% plus getting the employer match even for somebody who waited until they were 40. Because realize we used a rate of return assumption of 8%. We know if you just look at The S&P 500 typical index funds over the last 50 years has actually been into the double digits. So very easily this person, even though they might feel like they're behind Starting at age 40, good chance you're on the path. Especially if you can either bring in your Roth IRA or other saving baskets, you're a millionaire and that's a tremendous opportunity. So let's talk about what do you need to do to make sure you avoid this second trap. How do you get that match?
- [10:04]
Bo Hanson
Yeah, what you do is you go out and get the match. If you don't know, reach out to your HR department, read through your annual disclosure, read through the summary plan description, Figure out what is required for you to get that employer match. If you need to put in 6% to get 3%, do it. If you need to put in 5% to get 5%, do it. Make sure you understand what is necessary so that you're not leaving any money on the table.
- [10:30]
Brian Preston
I think people, when they see our system, the financial order of operations, they're always like wow, that's kind of unique that they have. Their step two is employer match versus paying off that high interest credit card debt. Guys, that is how important it is. Getting 50%, getting 100% rate of return is definitely more valuable than even paying a 20% which is highway robbery. It's predatory, but that's just how powerful that free money is. So get in there, maximize that opportunity.
- [10:59]
Bo Hanson
Alright Brian, we've talked about the mistake of people not contributing and then we've talked about the mistake of people not getting their employer match. Let's talk about a mistake that we see actual financial mutants make. These are people who have committed to saving in their 401k and building to future financial independence. And yet they still make this mistake. And we see this over and over and over again. It's cashing out your old 401ks.
- [11:22]
Brian Preston
You know, I'm one of those people you used to hear about these voyages because you're building wealth is a journey. It's a voyage. You think about what old land of Europe, when they first discovered America, you know that there was all Kind of wives tales and things about what would happen to these boats. And they would talk about mermaids who would come up and then lead people astray. And they'd come up with these crazy stories that would lead these sailors astray. Guys, I feel like in a lot of ways, this is what happens to the typical American with 401ks, because you're on this journey and you leave just so excited to start saving for the future. You know, yes, I'm going to let my money work for 20, 30, 40 years, and you go on this journey for 10 years, but then maybe you change jobs and then that siren song, that mermaid shows up for you and goes, hey, new car, new car, swimming pool. Be like Clark Griswold swimming pool in the backyard. And these are the things that lead you to cash out your 401k.
- [12:21]
Bo Hanson
And there are a lot of people that do that. 41% of Americans say they cash out at least a portion of their 401ks when they leave their job. Because while they're working there, the employer says, hey, you can't access this. You can't do anything. But when you leave, all of a sudden, now you get access to it. Now you can make bad choice. And would you believe that 85% of that, 41% of folks end up cashing out the entire thing? They end up saying, you know what? I was saving, I was building for the future, but now that I can actually put my hand to the cookie jar, I'm going to reach in and I'm going to grab all the cookies.
- [12:58]
Brian Preston
Well, in Vanguard, like, here's the thing, and this is why you're going to see the trap of young and decades away from retirement, as young people are, as Vanguard has found out in their research, are more likely to cash out these 401ks. And I kind of understand it from a behavioral standpoint, is because if you're in your 20s or 30s and you had $30,000 in your 401k, you're like, what's 30 grand good? What's forever grand? I mean, I'm not really missing out. I need a car right now. I don't have to worry about retirement for 25 years, but I need a car right now. You see how these mental traps can lead you astray. So let's put some numbers in this. Let's do a case study so people can say, don't fall into this mental trap.
- [13:41]
Bo Hanson
Yeah. We want to show you just how easily this one decision that we've already seen almost half of Americans make can cost you a million dollars. Let's assume that inside of your 401k, if you were to invest those dollars, you could earn an 8% rate of return on average. And let's also assume that you're going to plan on retiring at age 65 and you're not going to make any additional contributions. So the question I want to ask is how much of a 401k would I need to cash out to cost myself a million dollars? Well, this is what we found. If you're a 40 year old and you've changed jobs and you've been building up and all of a sudden you change jobs at 40 and your old 401k had $137,000 in it, you said, you know what, I've got a new job, I took a pay raise, I'll just save more and I'm going to cash out my old 401k. Just cashing out $136,000 could cost you a million dollars by retirement. If you're the 30 year old facing that same decision, just a $61,500 cash out could cost your future self $1 million. And if you're a 20 year old, just cashing out less than $30,000 in a 401 could end up costing your future self a million dollars. The earlier you cash out, the more expensive and the more tragic it becomes. Just like compounding interest can work against you when you have your dollars working for you, or just like compounding work for you when you have your dollars working for you, it can work against you when you take your army of dollar bills out of the game.
- [15:18]
Brian Preston
For those that are watching and listening, I think that I love the intersection point is the same. All these are the equivalent of $1 million at retirement. But you can see how the mental trap is set for you. And I like to think somebody in their 40s who have six figures, they're probably less likely. But remember, the Vanguard stat shows it's the younger people that fall in this. And I, you can completely see this because yeah, I know it's a little unrealistic to think a 20 year old has 28,000, but you can say probably a 25 or 26 year old very easily could have 25 to $30,000 in that 401k because they had a generous employer, they found our content and we're doing it. But then they realize, you know, no, I need that car or we've seen it Bo. I hate that we've actually experienced this with some of the plans we've managed swimming pools, pickup trucks, literally. I mean, even house down payments sometimes. I get it. You think that this is the easiest access point. Don't take from your future self if you want that 50, 60 year old version of yourself to cry those sloppy tears and give you that bear hug. Don't steal from yourself while you're still young and you think it's decades away. Trust me, from a guy who's in his 50s, time passes quickly and you're going to want to have that army of dollar bills working for your future.
- [16:35]
Bo Hanson
Another thing that's maybe even more devastating is if you did make this decision at 20 or 30 or 40, not only are you missing out on those dollars growing, but you're also going to be taxed on that distribution. It's be taxed as ordinary income to you. And if you're under 59 and a half, there's going to be a 10% penalty assessed as well. So not only are you robbing from your future self, you're literally throwing away dollars today. So what do you need to do? Make sure that there is no 401k left behind. There's no employer plan left behind. Just because you don't work at a job anymore does not mean that the dollars you saved at that job should not continue to be thought of and brought along with you to your future employment opportunities.
- [17:17]
Brian Preston
This is such a big behavioral trap that we've actually created and thrown the kitchen sink at these resources. So that's why don't worry, you're not on this. You're not just left to your own devices trying to figure this out. If you go to moneyguy.com resources we have a resource on if you have an old 401k, here's kind of a decision matrix on what to do. And don't even worry. Maybe you're one of those people you say I'm more of a visual learner. That even does. I don't even want to go to that website to download that resource. How about just go check out our show? We did a mini show with Bo on what to do with your old 401k that's going to highlight some of these things we created in the resource.
- [17:54]
Bo Hanson
That if you can be a solid commander of your army of dollar bills, they will work hard for you. But you don't want to make sure that you're not taking advantage of every single opportunity that's available to you. Okay, Brian, so now let's talk about again as we're kind of moving through these five mistakes, we're kind of going along the path of a financial mutant. So maybe you're someone who says, hey, I'm going to contribute to my 401k and I'm going to get the employer match. And even when I leave that job, I'm going to make sure I roll over my dollars. I'm not going to cash them out, I'm not going to spend them. But there is another mistake that even the people who pass all of those tests, they still fall into this trap. And it's not actually investing the dollars in your retirement plan or not knowing what your dollars are invested in.
- [18:42]
Brian Preston
Yeah, this one, this one hits me really to my core, is because y'all have heard me talk about, I feel like the journey of two families and my family invested in CDs because that's what my father knew what to do with. Meanwhile, my father in law, he had that Fidelity Magellan fund and his money just did a lot more. And I always think about the fact that. And then I think about my time as when I was a school board chairman of a school board for a large school system, when I found out that the 403B provider and the representatives that were sending out to talk to these teachers were actually encouraging all those teachers to go into stable value funds. And you know why they were doing it is because they knew that the teachers wouldn't complain when markets got beat up because they would feel very safe. But then they knew that they were set it and forget it. In these stable values, they'd make a little bit of something. But it made me feel horrible because these poor teachers, and I think this happens to a lot of Americans. What feels safe in the moment is actually risky in the long term. I will repeat that. What is safe in the moment is actually risky in the long term. You can actually invert that what is risky currently might be the long term safe way to build wealth or give you the best probability of success. Guys, do not fall in this trap of not letting your army of dollar bills work.
- [20:05]
Bo Hanson
Yeah, we talked about this a couple weeks ago in a. And it was sort of mind numbing then and it's still mind numbing today. Vanguard actually found that 1/3 of investors, 1 out of 3 who rolled their savings into an IRA in 2015 still had their balance sitting in cash seven years later. That means that there was a seven year period where someone said, hey, I'm not gonna leave the 401k behind. I'm gonna roll it over. I'm gonna bring it with me. I'm not gonna cash it out and make all the right decisions. And yet they didn't actually put the money to work and it just sat there in cash because they weren't paying attention. And while that may seem like an insignificant decision, it can actually be incredibly significant over the long term when you don't have your dollars working for you.
- [20:52]
Brian Preston
Yeah, once again, I love if we could actually take this mistake because once again, people think they're doing the right thing by just starting the behavior of actually putting money into these accounts. But if you're not doing the step two, which is actually putting the money to work, you're missing out. So we decided, once again, let's do a case study to show people how big of a problem this could be.
- [21:15]
Bo Hanson
All right, so let's assume that if you're going to have Money in the 401k, let's say that your cash or the stable value fund or the conservative option can earn 2%. But if you were to be invested in a target retirement fund or a well diversified equity style portfolio, you could earn 8%. So 2% versus 8%. We're going to assume that you're going to retire at age 65 and we're going to assume that the older you are, the larger your rollover balance likely is. So for a 20 year old, we're going to say, okay, what happens if I just don't invest $10,000 by 30 it's what happens if I don't invest 50,000 that I roll over? And by 40, what happens if I don't invest $200,000 that I then rolled over to an IRA? So we said, okay, how material can this be? So for a 20 year old, if you just have $10,000 that sits in cash over your entire working career earning 2%, $10,000 can turn into 25,000. It still grew, but it did not grow at the level you wanted to grow. Because had you invested that $10,000 and earned 8% over your entire working career, that single $10,000 rollover could be worth over $360,000. That is a $337,000 difference. That's significant.
- [22:30]
Brian Preston
Yeah, I even think about in the book I detailed how I left $10,000 out of like a Roth IRA. You could think about Roth 401k as the same way. And it worked out to be just like this, you know, is that it was over $300,000 difference on what my future self could have. Guys, this is why I don't want you to fall in that trap. You don't have to be perfect with your financial decisions, but you do need to make sure you're not leaving money on the table.
- [22:54]
Bo Hanson
All right, now let's look at the 30 year old. What happens if a 30 year old doesn't invest 50,000? Well, 50,000 from age 30 all the way up to 65, invested at 2% in a stable value or cash fund can still double. 50,000 can turn into $100,000. But if instead you would have invested those dollars and you could earn 8%, that 50,000 could turn into almost $815,000. It's a difference of over almost $714,000. And then if you're the 40 year old and maybe you've gotten busy and life is pulling you in a thousand different directions and you change, roll over that old $200,000 401k into an IRA and it just sits in the high yield cash option. That 200,000 could still turn into 330,000 by the time that you get to retirement. But if you could invest that 200,000, have it working for you, it has the potential to turn into almost a million and a half dollars. That's literally a $1.1 million difference over the last 25 years of your working career. Not paying attention can be incredibly costly. So know what you're doing with your dollars and whether or not your dollars are being invested appropriately.
- [24:08]
Brian Preston
And I bring this full circle back to think about my father. You know the hard part, if you ask me on the wealth building journey, what's the hardest part? It's actually the behavioral side of living on less than you make and creating the margin in your life that you actually have dollars that you can put to work. That's the hard part. So if you're a saver, congratulations, you've done the heavy lift. But this is what's so troubling to me. If you don't actually put the money to work, your army of dollars never have the opportunity to really harness that power of compounding growth. And that's exactly what this illustration is showing is guys don't do the hard part of it, but not actually just energize and engage the most powerful part of this. And that's actually letting your dollars start working for you. It's worth repeating what feels safe in the short term can actually be risky in the long term. Have a long term mindset and understand investing and doing index funds and other things can really be a great way to help you complete your financial journey.
- [25:09]
Bo Hanson
I love it. Alright, Brian, so now let's talk about the fifth mistake that we see. And again, this is one that we have seen. Even with great retirement plans and very intelligent people who even work inside of the financial industry, we see this be a problem over and over and over again. Again, I think it's the I wish you would do the mermaid siren song impression again because I think that's what happens. The fifth mistake we see is people using their 401k as a slush fund and taking out 401k loans.
- [25:38]
Brian Preston
Well, taking 401k loans is one of those things. You might think that you're being a financial mutant and doing a maximization strategy when you're actually making a long term mistake that's going to have big ramifications in the future. And what we've seen is, and this is the thing, 20% of participants have outstanding 401 loans.
- [25:59]
Bo Hanson
That's incredible. One out of five at any given time might have an outstanding 401k.
- [26:04]
Brian Preston
But it's even worse than that if you actually expanded that because we know different people are going to bop in and out of these loans if you expand this to a five year period and looked at that and said of the five years, how many participants, the number actually ballooned up to 37% of people. Almost four out of 10 people are falling into this trap and they probably think they're doing it for the right reasons. Because if you think about if you're paying off debt, if you're trying to buy a home, that's noble. Maybe you got medical expenses, education expenses, all these things are good and on the surface it can make sense to you. But guys, you have to understand that you really are taking money and you'll never get that time component. The opportunity cost on this be tremendous.
- [26:44]
Bo Hanson
But people say this all the time, they're like, no, no, no guys, you don't understand. 401k loan 1. My plan allows it so I can do it. I get to borrow my own money instead of borrowing from a bank and I can pay my self interest and it's not going to be a taxable event. There are so many pros to this. Well, let's not talk about the pros, let's talk about the cons and the downsides. First of all, and this is probably the biggest downside associated with 401k loans is you're missing out on compounding growth. We've already talked about that. These accounts are some of the most powerful accounts you have at your disposal. Where Your dollars can do the most amount of growing over your entire working career. When you take a 401k loan, you are literally taking your dollars out of the game. You are not letting them work for you. And the younger you are, the longer your time period is, the more costly that can be.
- [27:32]
Brian Preston
I think a lot of people are going to watch this and be like, you guys, you're a little tone deaf. Is because money is hard. And you know, and if I'm paying 20% to my credit card company and I can go pay myself interest out of my 401k, that's better. And I'm not going to disagree with you on that. But I want you to say this is definitely a measure twice, cut once. What I worry is this is the easy decision. Instead of you looking at your life saying, how did I get all this credit card debt? What consumption things led me to actually spend at this level that I now have to go pull out of my 401k to pay for this consumption? Don't. Maybe the first lever to pull is not going to take a loan. Maybe you first need to look at your consumption, your lifestyle, where you live, the cars you drive, you know, the clothes you wear. Focus on those things. When you triage your financial life before, you just go the easy way and say, hey, let's go grab that pot of money that I might need. I'm definitely going to need 30 to 40 years in the future.
- [28:28]
Bo Hanson
Well, another thing people don't recognize is not all 401k plans are structured the exact same. Did you know that some 401k plans, if you take out a loan, you can actually be prohibited from making contributions? That means that not only are you taking money off the table that was already on the table, you can't put any new money back on the table until you begin satisfying that loan. So that is a downside. And then the third downside, Brian, this is one that me and you talk about all the time and you being a tax guy, say these things can actually be a ticking time bomb.
- [28:59]
Brian Preston
Yeah, I panic about this because I see those stats and Megan and I were talking about this in the content meeting, is that unfortunately, a lot of these people that take the loans that you see a huge default ratio, meaning they leave employment and all of a sudden now they have 60 days to pay it back. Or this is considered a taxable distribution with penalties.
- [29:20]
Bo Hanson
Subject to penalties.
- [29:21]
Brian Preston
So I want you to think about it. What if you got laid off, you have now turned. How many bankruptcies are caused because people have medical problems or other things and they get these huge bills that they can't pay. By the way, this is the exact same thing, this is on the same branch of the tree, is that you have now created a situation, a tax bomb in your life that you have a bad situation, you get laid off from work, but you have this loan. And now not only did you lose your employment, not only did you lose your, your income from that employment, but now you have a huge tax bill that's going to come due. Because this money and penalties just, it's just, it makes me, it makes me sick. It really does. It makes me sad. And I don't want you to fall into that trap because you once again had that siren song that the easy path was just go take this loan. What could go bad? I'm going to pay myself back at this interest rate. Guys, I'm telling you, be careful. This could turn into what feels like the easy way could turn out to be one of the worst nightmares you've ever made.
- [30:17]
Bo Hanson
And then the other downside is 401k loans are often expensive as it relates to the interest rate. Right now the average 401k loan is somewhere around like prime plus 1 to even 2%. So we're looking at something between like 9 and a half to 10 and a half percent for 401k loans. But I can already hear the people saying, but guys, I'm paying myself, so, so what if it's a 9 and a half or 10 and a half percent interest rate? Surely that's good for me, surely that's valuable. Well, we said let's do an exercise, let's actually do a real, real life example of how costly this could be. So let's say that you're going to take a 401k loan out for $50,000. Your 401k is large enough that you can do that. And let's assume that the loan interest rate on that loan is going to be 10%. 401k loans, most of them, the longest period you can do is for five years or 60 months. So this loan is going to be on a payback, an amortized payback period of 60 months. And we're going to assume that principal plus interest is reinvested at the time of payment. So as you begin to pay back the loan, you're slowly putting the dollars back to work, plus the interest that you're having to pay on the loan. We're also going to assume that for the dollars, for the other side of the coin, the money you're investing is going to earn 10%. So if you didn't take out the loan, you could be making 10%. Or as you begin to pay back the loan, you are paying back 10%. Now, this is where we want to make sure that we compare apples to apples. You're going to take out a loan amount of 50,000. We want to compare that to just leaving that $50,000 invested. But if you're paying back a loan, not only do you have to pay back the principal amount, you also have to pay back the interest on that. So if we're going to do an apples to apples comparison for the leaving the $50,000 invested, we're going to assume that whatever the interest component was for each of those 60 months, we're going to now begin adding that to the $50,000. So you can actually see for the same level of cash outflow, what are you really walking away from? And this is what we found. Well, obviously if you took out a $50,000 loan and you paid it off over five years, at the end of five years, your loan balance would be zero. Well, as you were paying it back, you were paying back principal and you were paying back interest and you were investing those dollars and those dollars were growing at 10%, so that now the loan payments have now been able to pay back the loan and turn into 82,000. So over a five year period, you took out a $50,000 loan, you paid it back at the end of that five years, you end up with $82,000. Doesn't sound awful on the surface.
- [32:49]
Brian Preston
Remember, this is best case. This means you actually get to go the five years, pay it back, everything works out as planned. If you get laid off in year three or four, you got a problem, this whole thing blows up upon itself. So we're giving you the best case and still showing you why this might be a problem.
- [33:04]
Bo Hanson
So then we said, okay, what happens if you didn't take out the 401k loan and you just left your $50,000 invested plus the interest payments? Because again, we want to compare apples to apples. Well, if you did that over this five years, instead of only having $82,000 in your 401k, you have almost $101,000 in your 401k. Now remember, this is just a five year period and that's an $18,000 difference on a $50,000 sum. So that's pretty material over a relatively short time period.
- [33:35]
Brian Preston
Well, look, I know people are going to look at this and say that's only around $20,000 difference. Guys, that doesn't seem worth it. But remember, this is the easy path. What about if you could have done both? What if you. If especially like if you're paying off credit cards or other things like that, what if you would have figured out a way to not only keep your employer plan going to where you're getting the match and funding the basics, but maybe you cut your expenses somewhere else or you worked an extra shift or a gig economy job so that you could have that money. I just don't want people. The behavioral side is don't take the easy path. Sometimes make doing big things requires a little bit of scarcity and sacrifice.
- [34:11]
Bo Hanson
But we also want to show how significant that $18,000 can be, especially at different ages. So let's say that that 18,000 happened and you still had 20 working years left. After that 20 working years, that $18,000 could have meant a difference of $136,000 in your retirement portfolio. Maybe you have 30 working years left. If that's the case, that $18,000 could be the difference of $367,000 by the time you get to retirement of your young person and you make a decision like this at the beginning of your working career and you have an $18,000 difference between what you could have in your 401k and what you do have in your 401k. That single decision could be worth almost a million dollars. It's $995,000 after 40 years. So it seems like a small insignificant difference can compound through time and have huge ramifications on your ability to reach financial independence.
- [35:11]
Brian Preston
Yeah, I mean, if you couple the fact that we're showing you the opportunity cost loss, that 20 grand could turn into up to almost a million dollars. It also just could be the bad mistake, bad timing, bad luck that also becomes a huge tax bill or tax bomb. There's just a lot of risk here. So guys, once again, measure twice, cut once. If I was telling you what to do is try to at all cost if you can. If you're not in that desperate, desperate situation, leave your money invested. It really is probably the best path. It's not going to be the easy path, but that's okay. Sometimes little sacrifices and scarcity moments here can create your great big beautiful tomorrow.
- [35:52]
Bo Hanson
All right, so we told you five mistakes to avoid. Well, you probably ask. Okay, well great. That's the mistakes. What do I do? I want to be a 401k millionaire. What are the things should do? Not just these Things I shouldn't do. Well, here you go. Here's some simple steps to making the Most of your 401k and getting to that millionaire status inside account. How about automate your investments?
- [36:14]
Brian Preston
Yeah. Make those good habits as easy as possible.
- [36:17]
Bo Hanson
How about get your full employer match?
- [36:19]
Brian Preston
I love that free money. I love that free money.
- [36:22]
Bo Hanson
How about have a plan for your old 401ks when you change jobs or change employers, don't leave that money behind. Bring it forward with you.
- [36:30]
Brian Preston
See, we're supposed to be doing like a tag team. No 401k left behind.
- [36:33]
Bo Hanson
Bo, how about know what you're invested in?
- [36:37]
Brian Preston
Yeah, I mean look, if you, this is easy. Don't get, don't overcomplicate it. If you know what, how much money you can save and when you need it, you can do an index target retirement fund or just a basic index fund. This doesn't have to be complicated.
- [36:49]
Bo Hanson
How about when it comes to 401k and how you manage it, how about you just set it and forget it?
- [36:54]
Brian Preston
Remember at the beginning I said we're going to make the good habits as easy as possible. If you set it and forget it, you're also making the bad habits that much harder. If there's already a purpose for every dollar in your army of dollar bills, you're less likely just to waste it, to consume it and not let it become the best version of itself.
- [37:11]
Bo Hanson
401Ks are amazing tools that are available to most Americans. And if you're not taking advantage of it, maximizing your opportunities there, you're really missing out. So make sure know what you have available to you. Know how you can access and get the most out of your employer sponsors retirement plan.
- [37:28]
Brian Preston
Guys, we love giving you free content. We love loading you up. I would encourage you if you're new to the show. We have new people coming in every day. About 40% of you are new every month. Go to moneyguy.com resources. We are absolutely going to load you up with free content. But the big thing I love about 401ks is they really do allow you to maximize opportunity. If you can save just a little bit of today, it really can help you build your great big beautiful tomorrow. I'm your host, Brian Preston. Mr. Bo Hanson. Moneyguy Team Out.
- [38:01]
Bo Hanson
The Money Guy show is hosted by Brian Preston and Bo Hanson. Brian and Bo are partners with Abound Wealth Management. Abound Wealth Management is a registered investment advisory firm regulated by the securities and Exchange Commission. In accordance and compliance with the securities laws and regulations, Abound Wealth Management does not render or offer to render personalized investment or tax advice through the Money Guy Show. The information provided is for informational purposes only, may not be suitable for all investors, and does not constitute financial, tax, investment or legal advice. All investments involve a degree of risk, including the risk of loss.